Rumble in the urban jungle

Difficult to predict impact of the new rent law

Update: President Michel Sleiman announced he would not sign the rent law on May 7, 2014. The following article appeared in Executive’s print edition on May 1.

When Parliament approved the new rent law in early April, the document cleared a major hurdle, only to be confronted with a barrage of protests by people seeking to stop the measure while it was still on its laborious way to the printer via the presidential palace. The impact of the law, which would enable building owners to gradually increase annual rents to the equivalent of 5 percent of an apartment’s value, is difficult to assess given the country’s chronic lack of reliable data; however, it is clearly an issue of humongous proportions as up to 25 percent of rent contracts in the country are subject to the old law.

A lobbying group of tenants with old rent contracts staged street protests in Beirut’s main commercial districts of Ashrafieh and Hamra, making an outcry that the law’s implementation would force them out of their homes. They joined in a “day of pressure” on April 8 where demonstrators rallied for a range of salary demands and social issues, including a veto of the new rent law.

Brahim shows the rent contract of his parents’ apartment. He owns a shop in Mar Elias district in Beirut. He makes around $660 per month of which he pays $220 for his parents’ rent. With the new law, he says he will not be able to support his parents.

Building owners, desperate to see the rent law enter into force after years of parliamentary indecision on the matter, took to the streets with counter-demonstrations and sit-ins, grumbling that the old rent law had left them destitute and accusing tenants of all manners of deceit and hidden wealth. Media and bloggers came down on either side of the issue with sympathy or indignation, depending on their ideological color.

The commotion is more than understandable, given that the liberalization of rents will have massive consequences for incomes and economic prospects of the two directly involved groups: tenants and owners of properties with rent contracts that are over 22 years old. More significant impacts of the rent regime’s liberalization loom for the entire property sector, from the market for developable plots to the strategies of intermediaries and to the project planning of real estate developers.

While the demonstrations by both sides illuminated the social import of the rent issue beyond any reasonable doubt, representatives of the real estate industry have been reticent to speculate on the legislation’s impact on the property market, arguing that they could not comment until the law was validated by the presidential signature and published in the Official Gazette.

No comment

Massaad Fares, the president of the Real Estate Association of Lebanon (REAL), which is the syndicate of intermediaries, told Executive that he was in favor of a new rent law but added that the implementation would require additional prudence and should be flanked by measures such as creation of a rent index.

Mireille Khorab, the secretary general of the Real Estate Developers Association of Lebanon (REDAL) similarly said that the law entails unclear issues such as the rationale for the timeframe of rent adjustments and is, in its current form, “not a very practical law.” She argued that it was nonetheless good to have the new law because building owners previously carried the burden of providing affordable housing, which in her view “defies all logic.”

A release of many properties into the market might suppress prices for urban plots, some intermediaries fear. Others cite a potential for new opportunities but agree that it is much too early to make any definite conclusions on the market impact of rent liberalization. Khorab emphasized that more competition was generally good for the market and called the potential influx of a large number of properties “interesting.”

Economist Nassib Ghobril, whose Lebanon This Week publication at Byblos Bank provided one of the few salient descriptions of the measures foreseen under the law as it was approved by Parliament, sees the main impact of the new law in allowing property owners to do with their properties what they see fit.

“It will certainly have an impact on the market because property owners will be able to generate real income from their property if they want to keep their tenants and agree with them. If they want to recuperate their property, they can decide to put it on the market or give it to their children, or some may want to refurbish it. It is an individual decision,” Ghobril opined. For tenants with old contracts, the law gives a transition period of up to 12 years during which they can decide on their options and this was fair, he added, because they previously lived in their apartments “practically rent free.”

An older quagmire

The previous rent regime was ultra-low cost for tenants because although the law stipulated the freezing of rents under contracts existing prior to 1992, the bulk of these contracts had been signed before Lebanon experienced a period of hyper-inflation in the latter part of its civil war. Where less than 4 Lebanese lira would still buy a dollar in the fourth quarter of 1982, the peak of currency devaluation saw a dollar change hands for LL2,400 in October 1992.

The Lebanese lira came down from exchange rate peaks in 1993 and settled on the central bank-maintained band of around LL1,500 to the dollar but that meant that values of any rent contracts signed on the basis of the pre-inflation economy were reduced to a fraction of their original intent in the new dollar-pegged Lebanon. Rent control on the basis of the old rents gave tenants a free pass to live in their apartments for amounts that could hardly pay for a daily breakfast of bread and labneh in the post-conflict economy.

Corruption enjoys a fat cigar while the citizens get pummeled by their government

No one has ever alleged even a socialist twang in the policy mix of the various cabinets led by Rafik Hariri, but for understanding the rent control measure, it serves to recall that Lebanon entered the 1990’s in turmoil and social disarray, with masses of people living in squalor and often squatting in buildings that were not their own.

The issuance of the 1992 rent laws has been cited in media as rooted in legislation passed in 1944. However, given the approximate tripling of the population in that half century with no evidence of housing crises in the urban centers, the old tenancy laws of 1944 and 1974 appeared to be broadly supportive of social stability without causing huge distortions to the property market.

Protection of existing rental contracts via the 1992 rent law provided a minimum continuation of social stability and also an ad-hoc measure in the post-conflict period that kept people in their homes while the government had more than enough displaced and deprived families to worry about. The 1992 laws at the same time opened the market for new rental agreements and allowed for a minimal rate of adjusting old rents.

The same valuation dilemma as in rents applied to other social issues of the post-conflict period, such as the retirement remuneration of employees who accomplished a big part of their working life before the new currency fix. But while the severe problem of employee compensation is at least regressive with time, the rent stipulation with each progressing year became an increasing hardship for owners and has distorted the property market for at least the past 15 years.

Not only did the injustice of the rent controls mount over this period to an increasingly imbalanced financial tally at the expense of building owners, the market was artificially deprived of affordable rentals. Anyone moving to Beirut or leaving their parental home and seeking to rent faced a market with next to no choice of available flats and inflated rental prices for the scarce old apartments that were not rent controlled.

In this environment, no self-interested tenant under an old rental contract would be motivated to move into a newer, non price-controlled rental unit because no gain in ambiance and building quality could adequately compensate for the exponentially higher rent for a new unit. At the same time, tenants had no motivation to invest in upgrading the apartments they inhabited and building owners had absolutely no incentive to invest in refurbishment and structural upkeep of the non income-producing buildings. Thus Beirut’s districts increasingly turned into exhibition sets of the time-tested truth that rent controls are huge disincentives to gradual improvement of building stock.

Rent seeker vs. rent seeker

The old rent law’s market distortion is one of the factors that have contributed to today’s sharp contrast between new urban projects — all developed privately and based on assumptions of high per square-meter prices that can be realized from sales of new apartments — and the deteriorating or unimproved majority of building stock in the Lebanese capital.

The demands of both activist tenants and building owners smack of an economic behavior called rent seeking. The term is used in economics to describe efforts and expenditures made by individuals or companies to influence public policy for an economic gain without producing an added benefit to society.

Tenants who angle for continued rights to use their apartments effectively without paying or who ask for state subsidies in replacement of the old system are in this sense rent seekers. They act in their own interest but may be ignorant of the economic harm that Lebanon will incur by further cementing the current distortion of the property market.

Property owners who lobby the president to sign the rent law so that they can obtain higher revenues from their building stock aim to obtain — or recover — a surplus that has hitherto been pocketed by their tenants with the help of public policy can also be described as rent seekers. Building owners see themselves easily in a position of pursuing their rights but the desired extraction of value from the tenants does not necessarily mean that owners will contribute to a more productive and socio-economically beneficial use of the scarce and hideously mal-planned urban landscape.

This building in Moussaytbeh area will be affected by the new rent law

Against the objective to make Beirut a more productive city, the liberalization of rents and enforcement of private ownership rights is not a mechanism for progress per se. However, not changing the rent law and allowing any further prolongation of the status quo could only lead to more imbalances in the market.

A practical measure?

In operational terms, the law seems fair and simple at first sight. It offers holders of old rent contracts nine years of protected tenancy during which they undergo a gradual alignment of their dues with an undistorted market rent.

However, assigning market value to a rental property may not be a simple proposition. Tenants and owners may each take to procuring valuations from different experts and sworn property assessors may be swamped with work if all the — numbering 140,000 according to the Lebanese finance ministry — flats with old rent need to be valued.

Moreover, according to property intermediaries, who have experience encountering divergent and unclear valuations in property deals, a share of disagreements will be programmed into the procedure. While a healthy portion of owners and tenants will reach valuation agreements amicably, court disputes are unavoidable in other cases and clearly the overburdened court system will struggle to digest this new wave of litigation.

The process of apartment valuations and defining the future rents is therefore a logistical challenge fraught with foreseeable bottlenecks in a market that has hitherto been driven by the opposite of perfect information. New transaction costs will ultimately come to bear on the pricing of both rents and properties without the benefit of adding social value, meaning that in all likelihood the costs of living in Beirut will go up, but the quality of living will not.

Having been voted in by Parliament, the new rent law is closer to reality than ever before in the past 22 years since the current regime of rent laws 159 and 160 were adopted. According to the Coase theorem, transaction costs and imperfect information are the key problems that are likely to cause bargaining to be less than optimally efficient for solving property disputes.

State intervention, however, does not necessarily solve the problem. What the state should do, according to this economic theorem named after British Nobel economics laureate Ronald Coase, is not to intervene directly but first provide a clear and well-bundled definition of property rights of both parties, meaning rights and liabilities of owners and tenants. The state is then best advised to create institutions that minimize transaction costs under the insight that economic incentives are more conducive to effective bargaining than legal impositions.

The larger issue of making Lebanon more livable and its urban economies more productive would be the even worthier objective, whereby a new rent law would be an avant-garde component of a greater package comprising: a census to gain vital information that is currently unavailable to both public and private planners, legal frameworks and prudent strategies for infrastructures and urban planning that can actually be implemented, and the best possible regulation of markets in recognition of the fact that markets must be regulated to be efficient.